After a relief rally late last week, global markets resumed their decline early this week, seeing bad news everywhere and the continuing rout of Chinese stocks as a sign of worse to come.
Black Monday. Terrible Tuesday. Wicked Wednesday. The Great Fall of China. These are just a few of the online witticisms about China’s market woes brought on by fears of its weakening economy.
Thank goodness Chinese markets are closed until Monday for a holiday. Wednesday share prices in Toronto and New York rebounded.
One of the lessons of this summer’s market discontent is that you can’t defy the laws of economics, although you can defer the day of reckoning for a long time.
In the U.S., interest rates have been artificially low since the dotcom bust of 2000, when the U.S. Federal Reserve pushed rates down from 6.75 per cent to 1.75 per cent within 12 months. That set off the U.S. housing bubble which burst in 2008. That led to another round of rate cuts, creating a six year uninterrupted boom in stocks which has just collapsed. So here we are.
A whiff of a slowdown in China and things have come apart.
One of the big ironies is that China’s growth was supposed to carry us along by creating demand for our raw materials. We pretended that their economy and stock markets were mature. We overlooked the fact that a one-party, Communist state with a veneer of free market capitalism does not have the same rule of law, openness and transparency we take for granted.
In the past few months, the Chinese government had interfered at will, doing one thing one day and another the next.
Such things as arresting bloggers for spreading rumours, the government says caused the market collapse. Or at the height of the selloff, saying local governments can now use their pensioners’ retirement funds to invest in stocks. Measures that seem more aimed at showing that the government is all powerful have shown the opposite.
In the U.S., six years of near zero interest rates and an experiment that created billions of dollars out of thin air, gave investors the message the market is risk-free. American share prices rose accordingly, rising 80 per cent between January 2009 and Wednesday. Now the game of chicken is when will rates rise.
The U.S. economy is saying the time is now. Growth was 3.7 per cent in the second quarter. The labour market is tightening and inflation has been slightly higher in each of the last four months. The sensible thing to do would be to raise interest rates, however slightly, if only to send a message and stop another bubble from building.
Here at home, Statistics Canada says consumers spending pulled Canada out of a technical recession. The 75-cent (U.S.) dollar is at a levels not seen in a decade, which will mean inflationary pressure for imported food and all forms of manufactured goods we buy.
This is a market correction of significant proportions. It may be short and sharp, or it may be long and lingering depending on how the real economy reacts. It may be tough to take the gyrations, but what it does do is set the stage for the next big rise.
Take the long view
Recent market volatility adds up to more uncertainty and unnerving days when markets move in both directions. Keep in mind, in the context of your investments:
• There are safer ways to invest in China than its stock markets. Multinationals that do business there have financial statements you can read and understand. For example, CAE sells flight simulators and has pilot training centres there. Bombardier has been selling transportation equipment in China for 50 years. Dorel Industries bought two Chinese companies last year that make furniture for kids.
• Market selloffs always set the stage for recovery. On Black Monday in October 1987 U.S. shares fell 22 per cent in one day. They recovered that in a few months and there was no recession. Crashes in 2000 and 2008 were all followed by recovery. This one likely will too.
• Remember why you bought your investments. If they are good quality, they suffer last and recover first. The TSX hasn’t done as well as the Dow since Jan. 2, 2009, but by Wednesday the main Toronto index was up 50 per cent over that span. That’s a hefty gain.
• Low prices have a silver lining. It means a higher dividend yield. The Income Investor newsletter pointed out last week that a year ago Bank of Nova Scotia’s stock had a dividend was yielding 3.4 per cent. At the close of trading Wednesday the shares were priced at $58.45 to yield 4.79 per cent. In addition, the dividend had increased.